The fiscal cliff for means-tested benefits

posted by Roger Senserrich | 80sc
July 16, 2012

There has been a lot of talk lately regarding marginal tax rates. The debate, as usual, has focused in the tiny, minuscule slice of population that would be affected by a hypothetical tax increase to those making more than $250,000 as year (2% of the population), and how a three point bump in their tax rate would affect their willingness to work.

If a 39% marginal tax rate could turn hard workers into slackers and reduce investment, it might be interesting to explore other parts of the tax system with huge marginal tax rate spikes. To be more precise, we can look at how the tax system looks like for a family that is receiving some means-tested public benefit programs as they get close to the income limit for those benefits. Eugene Steurle, from the Urban institute (via Paul Krugman) has a very detailed study on the marginal tax rates for those families, and the picture is certainly not reassuring:

What we see in this graph is what happens as a family gets closer to the Federal Poverty Level (FPL) threshold and begins to lose benefit programs. The dotted line above is how the system is set up now; the line below is how the social safety net will operate once the Affordable Care Act (ACA) is fully implemented.

In real terms, a family that moves from 50 to 51% FPL (the cut off point for Medicaid) sees a 50% marginal tax rate, as a modest income increase is undermined the loss of benefits. The jump is even more pronounced in the 130% FPL line, where most families start losing SNAP benefits (food stamps) and the Earned Income Tax Credits (EITC) begin to phase out. A single mother might end up seeing marginal tax rates above 90%, with almost 90 cents of extra dollar earned going to cover each dollar of benefits lost.

If high marginal tax rates drive families to work less, we should pay less attention to what happens to the top 2% and look at the huge fiscal cliff that low income families face as they hit the income limits for means-tested benefits. The ACA will help to diminish this, as the subsidies extend much further (up to 400% FPL), but the problem remains: the non-universal, means-tested nature of much of our safety net ends up creating a huge incentive against getting out of poverty. Moving towards more universal programs (like Medicare or Social Security) is the only way to avoid these penalties.